Advanced Accounting for Oil & Gas Under IFRS: Key Issues

Understanding the accounting challenge

Why oil and gas accounting demands specialised IFRS knowledge

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Oil and gas entities operate through long project cycles, significant capital investment, uncertain reserves, complex contracts and substantial environmental obligations. These features create accounting questions that are rarely resolved by applying a single IFRS Accounting Standard in isolation.

From obtaining exploration rights to decommissioning a production facility, each stage of the value chain can change the recognition, measurement, presentation and disclosure of transactions. Finance teams must understand both the relevant IFRS requirements and the commercial substance of the arrangement being reported.

The challenge is increased by uncertainty. Exploration expenditure may not result in commercially viable reserves. Commodity prices can change impairment conclusions. Joint operating structures can affect how assets, liabilities, revenue and expenses are recognised. Decommissioning obligations may span decades and depend on assumptions that require regular reassessment.

The IFRS landscape for oil and gas entities

There is no single comprehensive IFRS standard covering the entire oil and gas industry. Instead, entities apply several standards across exploration, development, production, processing, transportation and sale. Accounting policies must therefore be designed carefully and applied consistently.

Exploration and evaluation expenditure

Exploration activities can involve geological studies, seismic work, exploratory drilling, licence costs and other expenditure incurred before technical feasibility and commercial viability are demonstrable. IFRS 6 provides a temporary industry-specific framework for exploration and evaluation expenditure after legal rights to explore have been obtained.

Management must establish an accounting policy that determines which exploration and evaluation costs are recognised as assets. That policy should be applied consistently and supported by clear documentation. Expenditure incurred before obtaining exploration rights and expenditure incurred after technical feasibility and commercial viability are demonstrable may fall under other IFRS requirements.

Key management judgements

• When does the exploration and evaluation phase begin and end?
• Which directly attributable costs qualify for capitalisation under the entity’s policy?
• How are exploration and evaluation assets classified and presented?
• Which facts and circumstances indicate that an impairment test is required?
• When should assets be reclassified into development or production categories?

Development and production assets

Once technical feasibility and commercial viability are demonstrable, expenditure is no longer accounted for under IFRS 6. Development expenditure may qualify for recognition under standards such as IAS 16 or IAS 38, depending on the nature of the asset.

Production facilities often contain significant components with different useful lives or patterns of consumption. Component accounting, depreciation methods, residual values and useful lives require careful assessment. A unit-of-production method may be appropriate for some assets when it reflects the expected consumption of economic benefits, but the inputs and reserve assumptions must be supportable.

Impairment in a volatile commodity environment

Oil and gas assets can be highly sensitive to commodity prices, reserve estimates, production forecasts, operating costs, discount rates and regulatory changes. When impairment indicators exist, IAS 36 requires the entity to estimate recoverable amount at the appropriate cash-generating-unit level.

The impairment model must be internally consistent. Forecast prices, production profiles, capital expenditure, operating costs and discount rates should reflect the basis required by the chosen valuation approach. The allocation of exploration, development, production and shared infrastructure assets to cash-generating units can materially affect the result.

Decommissioning and environmental obligations

Oil and gas entities may be required to dismantle facilities, remove equipment, restore sites or remediate environmental damage. IAS 37 governs the recognition and measurement of provisions, while IFRIC 1 addresses specified changes in existing decommissioning and restoration liabilities.

Initial estimates are generally discounted when the effect of the time value of money is material. Changes may arise from revised cost estimates, altered timing, new legal or constructive obligations, changes in discount rates or the passage of time. Finance, engineering, legal and environmental specialists often need to work together to ensure the obligation is complete and supportable.

Joint arrangements and production-sharing structures

Oil and gas projects are frequently undertaken with other parties to share funding, operational capability and risk. IFRS 11 requires classification based on the parties’ rights and obligations, not merely the legal form or the name given to the arrangement.

A joint operation results in recognition of the entity’s assets, liabilities, revenue and expenses in accordance with its rights and obligations. A joint venture is generally accounted for using the equity method under IAS 28. Contractual terms, legal structure, other facts and circumstances must all be analysed.

Production-sharing agreements, concession arrangements, farm-ins, farm-outs and carried interests may require additional analysis. Their accounting depends on the detailed substance of the rights transferred, consideration exchanged, obligations retained and stage of the project.

Revenue and commodity contracts

IFRS 15 applies to revenue from contracts with customers, including the sale of crude oil, gas, refined products and petrochemicals. The analysis may involve identifying performance obligations, determining when control transfers, assessing variable consideration and accounting for pricing or quantity adjustments.

Some commodity contracts may contain terms that bring them within IFRS 9 rather than IFRS 15, particularly when contracts do not qualify for the own-use exception. Long-term supply arrangements, take-or-pay provisions, provisional pricing, transportation terms and embedded financing effects require careful review.

Leases, service contracts and embedded rights

Arrangements involving rigs, vessels, pipelines, storage facilities, land or specialised equipment may contain a lease even when they are described as service agreements. IFRS 16 requires the entity to assess whether there is an identified asset and whether the customer controls its use throughout the period.

Capacity portions, substitution rights, decision-making rights and protective rights can be decisive. A well-designed contract review process helps ensure consistent lease identification and prevents material arrangements from being overlooked.

Presentation, disclosure and connected reporting

Complex accounting conclusions are only useful when users can understand their financial-statement effects. Disclosures should explain significant accounting policies, material judgements, estimation uncertainty, impairment assumptions, provisions, commitments, joint arrangements, financial risks and relevant sensitivity information.

Consistency between the financial statements, operational reporting, reserve information and sustainability or climate-related communication is increasingly important. Contradictory assumptions can weaken confidence in the reporting package and may indicate that key information has not been connected across the organisation.

Questions finance leaders should ask

• Are project costs classified consistently across exploration, evaluation, development and production?
• Do accounting policies reflect the entity’s actual contractual rights and operating model?
• Are reserve estimates, forecasts and impairment assumptions aligned and appropriately governed?
• Are decommissioning estimates complete, current and supported by relevant specialists?
• Have joint arrangements, farm-in and production-sharing terms been analysed beyond their legal labels?
• Are commodity contracts assessed consistently under IFRS 9 and IFRS 15?
• Could service agreements contain leases under IFRS 16?
• Do disclosures explain the judgements and uncertainty that matter most to users?